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Beating the High Cost of Personal Insurance

If you are a wealth manager who caters to doctors, real estate developers or jet owners, you ought to know about captive insurance. It’s a small-but-growing area of personal insurance that can provide cheaper coverage than standard plans.

If you are a wealth manager who caters to doctors, real estate developers or jet owners, you ought to know about captive insurance. It’s a small-but-growing area of personal insurance that can provide cheaper coverage than standard plans.

Corporate captive insurance has been a booming industry for the past 30 years—today about 80 percent of Fortune 500 companies have it—but only recently has it caught on for individuals. “Personal captives have been around for the last 10 years, but only in the last four or five years have they become somewhat of a staple or standard tool in the toolbox of high-end wealth managers,” says Gary Rathbun, president and CEO of Toledo, Ohio-based Private Wealth Consultants. “It’s very complicated. I figured I would never put one together. But the thing caught on. And now using captives to insure large risk is a significant part of our practice.”

Basically, captive insurance is another name for self-insurance, whereby an individual or group of individuals set up their own insurance corporation to provide their insurance coverage. It is particularly good for those individuals or professionals who tend to pay high insurance premiums. If the individual ultimately has a good claims history, he or she can then get back the reserves, plus any income it may earn, when he or she retires (i.e., when the coverage is no longer necessary)—less any tax payments to the IRS.

Rathbun offers a group of ER doctors in Texas as the “classic” example. “It’s very hard in Texas to sue an ER doctor for malpractice because you have to claim gross negligence,” he says. And yet, insurance companies lump ER doctors into the same insurance pool as other doctors who are at much greater risk of medical malpractice lawsuits.

“So, many of [the ER doctors] are paying $75,000 in premium for $100,000 in coverage,” Rathbun explains. He helped several groups of ER doctors go the captive route instead. Initially, the captive charges the same high premium but, depending on claims, it stops or slows down the rise in premiums over time. If there are no claims, the captive could be fully funded within a few years, he says, while in the example above, the doctors would continue paying the annual premium for as long as they were in the plan.

Rathbun says captive insurance also works well for people who own jets—the big liabilities there are passengers, fuselage damage and environmental harm—and large real estate developers.

“Commercial insurance makes sense in a competitive market, but for physicians and jets, commercial companies have struggled to find their equilibrium,” agrees Dennis Harwick, president of the Captive Insurance Companies Association. In cases like these, it can be better to self-insure, he says.

Setting up and running a captive insurance company isn’t easy and it costs money, too, so it pays to know what you are doing. It has to be a legitimate insurance company: You have to have an administration company that takes care of all the day-to-day workings of the insurance firm; you have to hire a claims administration person; there has to be a third-party qualified actuary that determines the risk and the premium; and it takes capitalization and investment managers to invest the reserves. In all, the expense runs between $40,000 to $50,000, industry experts say.

One way to make that easier—and cheaper—is to rent a cell, or a segregated account, from a captive that’s already established. Which option is better for a particular individual depends on the amount of premium he or she pays. “If you have $3 million to $5 million in premium a year, it makes sense to set up a captive. If you have $1 million to $1.5 million in premium a year, it makes more sense to set up a cell,” says Rathbun.

Captive insurance companies can be set up offshore or in a handful of states in the U.S. that have captive insurance-friendly laws and regulations, like Vermont and South Carolina. The District of Columbia, Arizona, Nevada and Hawaii also have favorable captive legislation, while Utah has just put captive laws on the books and Delaware is considering it, according to Harwick. But Vermont has been perhaps the most aggressive at courting captive insurance business, and today it is the second-largest captive insurer in the world in terms of premiums—with gross written premiums of around $12 billion—behind Bermuda.

In fact, the number of captive insurance companies set up to protect doctors against medical malpractice suits has doubled over the last four years in Vermont alone, according to Derick White, director of captive insurance at the Vermont Captive Insurance Association. Today the state has about 80 captive insurance companies dedicated to medical malpractice, up from 34 at the end of 1999.